Can Washington state displace Silicon Valley?

California’s venture capital market is about 10 times bigger than Washington’s, both in terms of deals and dollars.

So what is it going to take for Washington to grab a larger share of that market?

Maybe a major geological disruption, with OVP Venture Partner’s Chad Waite joking this morning at the Washington Technology Industry Association’s breakfast meeting that one way Seattle could move up the venture capital charts is if there was “an earthquake on the San Andreas fault.” (The fault runs right through the middle of Silicon Valley.)

In other words, barring a natural disaster, don’t look for Silicon Valley to be displaced by Seattle or other tech hot spots any time soon.

Madrona Venture Group’s Matt McIlwain — who also served on the panel — has a more achievable goal for the Washington venture capital industry. In 10 years, he believes Washington could surpass Massachusetts to become the second biggest beneficiary of venture dollars. (Massachusetts recorded 100 deals and $697 million during the first quarter, which compared to 41 deals and $314 million in Washington).

McIlwain

“Number one is not worth shooting at. But I think we can actually overtake Massachusetts in time, maybe not in bio(technology). I think that is harder because there is much broader and deeper base of university research and medical research going on there. But I think it is aspirational and I think it is something that can be done. Quite frankly, I think one of the most important things and one of the things we should all be rooting for is Microsoft’s success, Amazon’s success, Clearwire’s success, RealNetworks’ success. The more of these companies succeed, the better in that 10 year onus of time of achieving that goal.”

I also served on the panel, pointing out that Washington has been on a fairly steady pace of venture capital investing in recent years.

In addition to discussing the state of venture capital in the region, Waite and McIlwain also addressed some of the changes in the venture business. One of the interesting exchanges occurred after I noted that entrepreneurs today appear to be more capital efficient than those of 10 years ago, a point that I lifted directly from some of the great discussion on this blog in recent weeks.

Waite OVP photo

That prompted a debate about the value of venture capital, with McIlwain and Waite agreeing that they actively look at early-stage deals that require very little capital.

“I’ve said this so many times, it is like a broken record. When we are looking at a project … there is nothing that comes through our door that is too early,” said Waite. “I have made five, six investments in the past 10 years where the first amount of money in is $250,000 or $300,000.”

McIlwain noted that Farecast — the online travel startup that recently sold to Microsoft for $115 million — was incubated at Madrona with a couple hundred thousand dollars before it landed additional venture funding.

The difference, according to Waite and McIlwain, is the mindset of the entrepreneur and whether it aligns with the goals of the venture capitalist. Venture capitalists are looking for the big home runs that can provide huge returns for the fund, which doesn’t always wash with the expectations of entrepreneurs who may be uncomfortable shouldering that much risk. But in some cases it does align where both entrepreneur and venture capitalist “believe that there is something big and disruptive to create” that is worth everyone’s time, McIlwain said.

On the flip side, Waite noted a recent deal in which he thought a company needed $5 million to $7 million to reach significant milestones. But the entrepreneurs didn’t want to take on that much capital out of fear that their equity stakes would be diluted. Instead, they were looking to raise $2 million.

“My immediate reaction is, wrong answer. Not interested,” said Waite. “And it’s because, to me, that was the insight that these guys cared more about what they owned of the pie than the size of the pie.”

That statement highlights a divide in the venture capital world, with firms like OVP having to swing for the fences at the same time that some entrepreneurs have more modest goals. (Of course, it is getting harder to swing for the fences with the IPO market essentially dead, but we didn’t get into that topic today.)

Waite has no problem with entrepreneurs that are satisfied with building a smaller company, but he said they probably don’t fit the profile of a venture investment.

“The $100,000 or $200,000 startup is fine. That’s great. I love those people, they are wonderful. But you have to understand the economics on our side,” he said. “We manage a $250 million pool of money and we can’t make 100 investments because we can’t staff them. So we have to make a limited number of investments and for us to stay in business, we have to have some home runs. We have to have some investments in our portfolio that are going to make 15, 20 or 30 times our money. That is just the reality of it. People who are not willing to go for that home run, shouldn’t take money from people like us.”